Abstract
Background: The financial sector plays a pivotal role in enhancing sustainable economic growth and development. The study looks at how institutions influence financial sector development (FD) and stability.
Aim: The study investigates the effect of state institutions on FD in the Southern African Development Community (SADC) region. The investigation considers the impact of institutions alone and the moderating effects of capital inflows on FD.
Setting: The study uses a panel of 15 SADC countries for the sample period 2007–2021. One country (Comoros) was left out because of the unavailability of data. The region has diverse economic structures allowing for analysis of institutional quality indicators and their impact on FD.
Methods: In this study, a quantitative approach was used to analyse the data with the system Generalized Method of Moments (GMM) econometric technique. Panel Granger causality testing at country level was also carried out.
Results: The different indicators of institutions showed varied impacts on FD. Rule of law, control of corruption and the overall institutional quality proxy show a negative and weak impact on FD, whereas voice and accountability, political stability, regulatory quality and government effectiveness show a weak and positive impact on FD. However, when moderated with the capital inflows variable, the results portray improved significance and positive influences on FD.
Conclusion: An environment of strong institutions, together with capital inflows, is critical in the overall development of the financial sector. The SADC region’s openness to trade has harmed the local financial sectors to some extent. Hence, the need for tightening some restrictions on international trade policies.
Contribution: The study provides insights into the specific institutional quality measures that influence FD within the SADC region, considering the moderating effect of capital inflows. These results can be used by SADC countries and relevant government agencies in designing and implementing policies that strengthen institutional frameworks and promote FD.
Keywords: institutional quality; financial sector development; GMM; SADC; capital inflows.
Introduction
Various studies have developed a consensus that institutions play a crucial role in the development of financial sectors in both developed and developing countries (Bekana 2023; Ekşi̇ & Basar 2020; Olufemi & Muazu 2019; Sabir, Rafique & Abbas 2019). Institutional quality has a direct impact on the growth, stability and accessibility of financial services. The successful expansion of financial services and institutional quality has the potential to increase investment, create safety networks and ultimately raise national gross domestic product (GDP) (Gibogwe, Nigo & Kufuor 2022). As highlighted by Opoku, Ibrahim and Sare (2019), a well-developed and organised financial system, particularly in developing countries, has the ability to draw financial resources from the developed offshore into the developing regional blocs. However, the effective transfer of financial resources can be realised when sound institutional frameworks are established. Institutions establish the legal framework that guides financial sector performance, ensuring transparency, accountability and providing investor protection. Furthermore, institutional quality contributes to the development of a robust and competitive financial sector by encouraging competition, innovation and risk management practices (Amir & Gokmenoglu 2020). Based on these theoretical postulations, this study investigates the state of institutions in the Southern African Development Community (SADC) region and how they are impacting financial sector development (FD), taking into consideration the moderating effects of capital inflows. The empirical analysis provides insights on policy decisions that seek to foster sustainable economic growth and financial sector stability across the SADC region.
Institutional and financial sector overview
According to the World Development Indicators (WDI), the strength and consistency of institutions in a country can be measured in terms of rule of law, control of corruption (CC), regulatory quality, political stability and absence of violence, government effectiveness, voice and accountability. The indices presented in Table 1, averaged per country over the period 2010–2022, describe the state of institutions in the SADC region, from a scale of -2.5 (weak) to 2.5 (strong).
In terms of the rule of law index, Mauritius, Botswana and Namibia show a relatively stronger rule of law in the SADC region. On the extreme end, Democratic Republic of the Congo (DRC), Angola, Zimbabwe, Madagascar and Mozambique show a weak rule of law. Such negative rule of law is possibly a cause of poor institutions in these countries.
Corruption control appears to be too weak in Angola, DRC, Madagascar and Zimbabwe, whereas Botswana, Mauritius, Namibia, Seychelles and South Africa have a relatively strong CC in the SADC region. The latter countries are again shown to be stronger than others in all remaining indices, which are: regulatory quality, political stability, government effectiveness, voice and accountability. Based on the data extracted from the Global Economy Indicators (2022), the DRC, Angola, Zimbabwe, Madagascar and Mozambique, in general, have poor institutional quality in the SADC region.
The SADC bloc has attempted to build a market-driven regional financial services sector by advocating for liberalised financial markets (Mahawiya, Haim & Fosu 2020). Through the Protocol on Finance and Banking, and the Regional Indicative Strategic Development Plan, SADC has reiterated the importance and pursuit of creating a favourable investment climate and cooperation in activities conducted by development finance institutions in the region. In its quest to achieve this objective, the SADC has embarked on creating a functioning and competitive financial services sector by allowing new financial institutions to emerge and develop new products (SADC 2020). In the SADC region ‘there is no uniformity in terms of stock markets, as countries are at various stages of development’ (Committee of Central Bank Governors in SADC 2014). Some member states have relatively more developed financial systems than others. Figure 1 shows the trends of selected financial sector indicators – aggregate broad money, market capitalisation and stocks traded in current US$ for the 16 SADC countries.
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FIGURE 1: Trends in financial sector indicators in Southern African Development Community. |
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Figure 1 shows that broad money has been above other indicators for the entire 20-year period. Broad money has been on a sustained increase throughout the period being examined, with a sharp increase observable between 2005 and 2011. The SADC Statistical Bulletin (2021) reports that Mauritius, South Africa and Seychelles together make up more than 50% of broad money in the region, while Madagascar has the least supplies. According to Bara et al. (2017), South Africa as an economic giant in the Southern African region, has been experiencing growth in liquid liabilities coupled with increases in broad money post-1994. Gwenhamo and Thomas (2013) reiterate that because of the high degree of trade and financial openness within the bloc, there are significant spill overs from South Africa into neighbouring countries through financial interlinkages. An increase in FD in South Africa intrinsically supports the development of financial sectors in other SADC countries. These spill overs can also be attributed to the use of the South African Rand in four SADC countries (Namibia, Swaziland, Lesotho and Zimbabwe) through the Common Monetary Agreement, which results in more financial flows between these countries via cross border trading and remittances. The sustained increase in liquid liabilities in Zimbabwe has been spurred by the hyperinflationary period that the country has gone through since the early 2000s (Tembo & Makina 2013).
Market capitalisation and the value of shares traded display almost constant values throughout the period under examination. However, between 2000 and 2003, the World Bank did not record any market capitalisation from SADC countries investigated. It is reported in the study conducted by Tembo and Makina (2013) that ‘it is only South Africa that has a recognised bond and securities exchange market’. In other countries, stock markets are still developing or are non-existent; hence, very low values of stocks traded and market capitalisation are observed.
It is also of interest to evaluate aggregate financial development based on indicators (broad money, market capitalisation and stocks traded) within SADC relative to other economic regions (Figure 2).
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FIGURE 2: Aggregate financial sector development indicators (US$1m) for regions. |
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In terms of FD, Figure 2 shows that the European Union (EU) has generally performed better than African countries throughout the period 2007–2022. When comparing African regions alone, there has been a clear and sustained rise in financial development from the period 2010 onwards. The SADC region has consistently performed better than other regions (Economic Community of West African States [ECOWAS] and North Africa). According to Gasimov Asgarzade and Jabiyev (2023), the SADC region has relatively more stable economies compared to ECOWAS and North Africa. This stability is attributed to better governance, political stability, sound economic policies, well-developed infrastructure and rich natural resources, all of which attract investment. Meanwhile, the ECOWAS region has been the lowest performing within the African continent (World Bank 2022). Figure 2 shows financial development trends for SADC, ECOWAS, North Africa and the EU.
Literature review
Theoretical framework
The study is underpinned by the Law and Finance framework by La-Porta et al. (1997), which suggests that institutions determine FD through the effectiveness of legal systems, particularly property rights protection and contract enforcement. As the theory emphasises the importance of the legal environment, it therefore follows that rule of law and regulatory quality are critical in determining finance-led growth (Ellahi et al. 2021). The theory suggests that countries with ideal systems and well-functioning institutions provide a secure environment for investors and lenders, which facilitates transactions and reduces information asymmetry. The theory further suggests that countries with well-established financial intermediaries are more likely to have efficient and well-functioning financial systems. There are several studies that have been conducted on institutions and FD based on the Law and Finance theory (Allen et al. 2005; Becht et al. 2002; Beck & Levine 2003). These studies commonly argue that improving legal institutions positively impact FD, which will ultimately lead to economic growth and development.
Empirical literature review
A recent study carried out by Bekana (2023) examined the governance quality and financial development utilising the system Generalized Method of Moments (GMM) econometric technique for a panel of 45 African countries from 1996 to 2018. This research demonstrated that development in governance institutions promotes financial development. Bekana indicated that because of diversity in the levels of FD across Africa, governance policies ought to be tailored differently for each country. The magnitude of the impact of governance quality is perceived to be relatively higher in countries with better FD than those with poor FD. Thus, it is the FD that determines the quality of governance.
An investigation conducted by Kombo and Koumou (2021) focused on the crucial role of the quality of institutions in financial development of Central African Economic and Monetary Community (CEMAC) countries. The study used panel data over the period 2002–2018 for all six CEMAC countries, and employed the dynamic ordinary least squares (DOLS) technique for estimation and analysis. The institutional quality variables that Kombo and Koumou (2021) used yielded varying results. It was revealed that the quality of regulation and political stability generally reduce the level of financial development in the studied countries. Conversely, CC and compliance with national laws and regulations positively impact financial development in CEMAC countries.
There are conflicting findings on the impact of political stability and corruption on the financial sector. Contrary to Kombo and Koumou (2021), Moustafa (2021) provides evidence that corruption, particularly in developing countries, acts as a helping hand in attracting foreign investment, that will boost FD. In terms of the role of political stability, Gankou, Bendoma and Sow (2020) and Rehman et al. (2020) contradict Kombo and Koumou (2021) in proving that political stability paves the way for FD. Therefore, further investigation is needed on the role of these two institutional quality variables (political stability and CC) in FD and investment.
Utilising a sample of 36 sub-Saharan African countries from 2000 to 2017, Asafo and Asmah (2020) examined the moderating role played by institutions on financial development towards economic growth using the GMM estimation technique. The authors used the following indicators as proxy for the institutional quality variable in the estimation model: voice and accountability, government effectiveness, rule of law, CC, regulatory quality and the polity 2 score that was developed by the Polity IV project. Empirical results revealed that all institutional variables used were effective in influencing the role of institutions on financial development. Political stability appeared to be the driving force among the institutional variables in sub-Saharan Africa. A similar study but with contrasting results, is that of Effiong (2016) who investigated the impact of financial development on economic growth and institutions as a moderating variable for 21 sub-Saharan African countries over the period 1986–2010. The study employed pooled ordinary least squares (OLS), difference GMM and system GMM econometric techniques for estimation and analysis. The findings revealed that accounting for institutions in the model prompts financial development to stop having a significant impact on growth and development of the studied sub-Saharan African countries.
Using an autoregressive distributed lag (ARDL) bounds test technique to cointegration, Fagbemi and Ajibike (2018) examined the short- and long-term effects of institutional quality on financial development in Nigeria from 1984 to 2015. Empirical findings indicated that institutional quality does not affect financial development both in the short and long run. Two separate measures for financial development were used, namely, credit to the private sector and broad money. Findings imply that either Nigerian institutions are too weak to carry out duties, or the country’s financial system is not advanced enough. The former may be significantly correct given that institutions often have little impact on financial development in an unfavourable institutional context, as also asserted by Kombo and Koumou (2021) and Effiong (2016).
An empirical study carried out by Raheem, Bello Ajide and Adeniyi (2016) sought to ‘examine the significance of institutional quality in financial development and the output-growth relation’ utilising the two-step system GMM econometric technique, for the sample period 1996–2012. The study looked at 71 economies, which were categorised into three groups: developing, emerging and developed economies. The findings show that volatility negatively impacted financial development. It was also revealed that reforms in the institutional framework have a reducing impact on output-growth volatility. As concluded by Raheem et al. (2016), the existence of sound institutions improves financial development through output volatility reduction. The same sentiments were also echoed by Ellahi et al. (2021) who found institutional governance as key in developing the financial sector. A proxy of the World Governance Indicator (WGI) as a measure of institutional quality revealed a strong positive impact on the FD of the Asian countries that the study investigated over the period 1996–2018. It is imperative that policymakers design macroeconomic policies, which can create a conducive environment for optimum levels of FD. This can be achieved by making new rules and regulations, the fundamental element of any institutional framework. This is also supported by Laporta (1998), Asafo and Asmah (2020), Kombo and Koumou (2021), and Hayat (2016).
Research carried out by Khan et al. (2019) examined the impact of institutional quality on financial development for both emerging and growth leading economies. Using cross-sectional tests, the authors found that trade openness, national culture and growth have a positive interaction with institutional quality. In another study, Gazdar and Cherif (2014), assessed the impact of institutions on financial development in 18 Middle East and North Africa (MENA) countries covering the period 1984–2007. The panel and IV estimation results showed that institutional quality is more important to financial institutions than to financial markets. Composite indices were used to represent institutions. Empirical results revealed that different institutional variables have different effects on financial development. For example, law and order has a greater impact on the development of financial institutions, whereas corruption and investment profiles have a lesser impact. Investment profiles largely influence the development of the stock market. This makes it clear that when analysing the impact of institutions on economic indicators, researchers should consider individual impacts first before combined effects.
In a similar study carried out in the same MENA region, Cherif and Dreger (2016) assert that in the presence of a functioning financial sector there will be effective capital resource allocation. In this study, the authors sought to examine the role played by financial institutions in affecting the financial system of an economy. A panel econometric technique with annual data for the period 1990–2007 was used by Cherif and Dreger (2016). Corruption, quality of the bureaucracy, and law and order were used as institutional factors. Results demonstrated that institutional elements continued to appear to be crucial even after accounting for macroeconomic variables and fixed effects. Corruption was a major factor in the development of the banking industry, and corruption as well as law and order were important factors in the development of the stock market. To enhance financial development, the authors advocated for greater law enforcement and anti-corruption procedures.
Also focusing on MENA countries is a study conducted by Sarhangi et al. (2021), which utilised a system GMM model to investigate effective governance and regulatory quality of financial development during the period 2002–2009. Findings revealed that both government effectiveness and regulatory quality had a negative impact on the financial development of the countries studied. The authors attributed this negative impact to the fact that financial markets are extensively liberalised, resulting in weak management of the financial system and inefficient resource allocation. The authors recommended that governments reduce the size of their bodies and optimise economic freedom in endeavours to sustainably develop financial sectors.
An empirical study carried out by Feng and Yu (2021) examined ‘the role of institutions in the regional financial development of 11 East Asian countries’, covering the period 1996–2017. The authors used six economic-institutional variables and six legal-political variables. The economic-institutional variables used were: property rights, monetary freedom, trade freedom, business freedom, fiscal freedom and investment freedom. The legal-political variables used were: political stability, CC, rule of law, government effectiveness, government spending and regulatory quality. Panel data estimation techniques revealed that the economic-institutional variables had a significantly positive impact on financial development, except for monetary freedom and government spending, which portrayed a negative impact. Legal-political factors were also found to be significant determinants of financial development in Eastern Asia. However, the extent to which these factors impact financial development differs for different countries, even those within the same regional bloc (Gazdar & Cherif 2014; Kombo & Koumou 2021).
Specifically focusing on government efficiency, Amir and Gokmenoglu (2020) employed fixed-effects (within) regression, random-effects (GLS) regression and generalised least squares regression (FGLS) to analyse the role of government efficiency on financial development for 31 Organisation for Economic Co-operation and Development (OECD) countries for the period 2001–2015. The authors demonstrated that the coefficients for government effectiveness, as an institutional variable, were positively significant across all three models utilised in the study. The results of each model confirmed one another. Gazdar and Cherif (2014), Gankou et al. (2020), Feng and Yu (2021), Amir and Gokmenoglu (2020), all recommended that to enhance financial development, policymakers in the OECD, and other countries with similar political and socio-economic traits, should devise ways to improve government efficiency.
An empirical study performed by Alsagr and Van Hemmen (2022) investigated the asymmetric influence of corruption on the financial development of BRICS countries (Brazil, Russia, India, China, and South Africa) from 1991 to 2018. In this investigation, the authors utilised novel panel non-linear autoregressive distributed lag (PNARDL) techniques and revealed that corruption asymmetrically impacts financial development. The study concluded that long-run negative shocks of the CC index has significant negative impacts on FD. Meanwhile, long-run positive shocks of the CC index are not significant. Both positive and negative shocks of corruption in the short run are also insignificant. Also focusing on corruption and financial development is a study carried out by Ekşi̇ and Basar (2020), which utilised the GMM econometric technique on 19 Eastern Europe and Central Asia countries. Annual data covering the period 2012–2017 was used. Findings demonstrated that there was no significant relationship between the level of corruption and financial development for these 19 countries.
The studies of Law and Demetriades (2006), Muye and Muye (2017), Phong (2020) all investigated the joint effect of trade openness and institutions on financial development. These studies had similar findings, in that trade openness and institutions play a critical role towards FD. In the study conducted by Law and Demetriades (2006), a dynamic panel data estimation technique was employed for 43 developing countries from 1980 to 2001. Findings revealed that trade openness was much stronger in promoting financial development in middle-income countries and weaker in low-income nations. However, Muye and Muye (2017) used several econometric techniques to investigate the dynamic effect and causality among trade openness, institutions, and financial development for Asian, BRICS, MINT (Mexico, Indonesia, Nigeria, and Turkey) and ECOWAS regions covering the period 1980–2000. Findings revealed a significant existence of cointegration among the study variables. Causality runs from openness to institutions, and in turn, institutions determine financial development. It was further revealed that openness had a causal impact on the financial sector, even when bypassing the institutional channel.
An investigation by Marcelin and Mathur (2015) on the effects of property rights and legal institutions on the performance of private firms, financial markets development and economic growth found that direct involvement of the state in running firms tends to fuel corruption, which is detrimental to FD and growth. As a result, the public sector would be left burdened with contingent liabilities. The study further revealed that the private sector performs better in countries with superior regulatory and legal frameworks. In the presence of strong governing institutions, private firms can easily thrive and significantly contribute towards overall macroeconomic growth and development. However, poor countries with poorly governed institutions should consider partial-privatisation and loosen up on the protection of property rights.
The overall size of the financial sector and its development is significantly affected by the quality of institutional frameworks. From the reviewed empirical studies, it was discovered that institutional quality variables impact FD differently (Kombo & Koumou 2021). Improvement in components of institutions can either positively or negatively contribute to financial development efforts. Most studies reviewed used financial sector indicators from the banking sector, stock market indices and openness to separately represent FD. It is however important to observe that FD encompasses many variables other than the ones widely used in empirical studies.
Faced with uncertainty of changes in regulation and institutional frameworks, some economies may fail to reach full financial development potential (Olufemi & Muazu 2019). Productivity growth in various industrial sectors is more likely to be determined by the extent of development of financial institutions and the stage of economic development that a country is in (Orji, Ogbuador & Anthony-Orji 2015). As SADC member states are relatively low-income countries and still developing, these nations are likely to benefit more from the development of institutions as compared to developed economies (Tembo & Makina 2020).
Data and empirical methodology
The study used annual data sourced from the WGI and WDI of the World Bank from 2007 to 2021 for 15 SADC countries. The study tested the following two hypotheses:
H0: Institutional quality does not impact financial sector development.
H1: Institutional quality impacts financial sector development.
The countries and study period were chosen based on data availability. The study adopted with modifications the model developed by Khan et al. (2019) as follows (Equation 1):
where FD represents the financial development proxy created through principal component analysis (PCA). The PCA eigenvalues are provided in Appendix 1. INSQ are institutional quality variables; zit represents the control variables of FD across the countries, and μit is the error term.
Considering other factors in the SADC region, Equation 1 was further expanded to be Equation 2:
where α, ω, γi are the parameters estimated by the study, and FDit−1 is the lagged variable of the dependent variable FD.
The multivariate regression equation utilised in the study is therefore given as Equation 3:
Definition of variables and a priori expectations
INSQ represents institutional quality, which measures the power, consistency and robustness of institutions in countries. INSQ involves various interconnected processes and institutions (Khan et al. 2019). Thus, only using a single proxy to measure INSQ may lead to inappropriate estimation. The study uses a composite proxy indicator constructed by considering proxy measures extracted from the WGI from the World Bank. The composite measure is constructed through the PCA in Stata econometric software. Good INSQ is expected to positively impact FD. It is also important to examine how each institutional quality variable affects FD; hence, separate models that break down the INSQ proxy are incorporated in the analysis.
Financial sector development is calculated as a composite proxy, derived from the PCA procedure of the following financial development measures: market capitalisation to GDP ratio, value of shares traded, broad money and domestic credit to private sector.
Generalized method of moments method
To examine the impact of institutions on financial development, the following GMM model is estimated as Equation 4:
where α, ω, γi are the parameters estimated by the study, and FDit−1 is the lagged variable of the dependent variable FD.
This follows the work of Khan et al. (2019) who highlights that there is likely to be reverse causality between financial development and institutional quality. Institutional quality is likely to be affected by the error term. Therefore, an instrumental variable model is important. This will be able to effectively deal with the problem of endogeneity. The study also considers GMM diagnostics, which test for instrument validity and autocorrelation of the error term. The tests for instrument validity are the Hansen (1982) J-test and the Sargan (1985) test.
To improve the robustness of the empirical analysis, the study analysed the impact of individual institutional quality variables on FD with different models. The study further investigates the interaction of institutions and capital inflows in explaining the development of the financial sector in the SADC region. The second set of models captures the interaction effects of capital inflows (CI) on each institutional variable and on the institutions proxy (INSQ).
Presentation of empirical results
Firstly, a correlation matrix of all the key variables used in the study is presented in Table 2:
Table 2 shows correlation of all key variables. The institutional variables show both positive and negative correlation with the dependent variable, FD. Some multicollinearity among the variables potentially affects the independent effect of each variable on financial development, hence, the considerations of assessing the joint effects of the variables on FD as presented in the estimation results. After establishing the correlation between the study variables, the next step was to run the regressions to establish the statistical impact of institutional quality variables on financial development.
Several models are estimated to analyse the individual effect of institutions on financial development. The results from the system GMM are presented in Table 3 and Table 4, with the coefficient and standard error of each explanatory variable given. Table 3 presents the individual impact of explanatory variables on FD, and Table 4 presents the joint effects of institutions and capital flows on financial development.
| TABLE 3: The generalized method of moments estimation results, models 1–8. |
| TABLE 4: The generalized method of moments estimation results with interaction variables, models 9–15. |
Results show that institutional measures affect the financial sector differently. Political stability (PS), government effectiveness (GE), rule of law (RL), CC, and the overall INSQ measure are revealed to have a negative impact on FD, with PS showing statistical significance in models 2 and 7 at the 5% and 10% levels, respectively. This is however inconsistent with prior expectations and other available studies (Asafo & Asmah 2020; Bekana 2023; Hayat 2016; Kombo & Koumou 2021; Raheem et al. 2016). This can be attributed to the unstable political environments in several SADC countries, such as the DRC, Zimbabwe, and the recent insurgency in Mozambique (Biniza 2021). Problems of state capture can also weaken the government effectiveness; for instance, the Zondo Commission in South Africa highlighted state capture challenges that were affecting the country (Klaaren 2023). A stable environment with effective governance is expected to enhance the development of financial sectors, ceteris paribus. As demonstrated by Gankou et al. (2020), Asafo and Asmah (2020), Rehman et al. (2020) and Sarhangi et al. (2021), political stability aids financial development of either developed or developing countries. However, Arcand, Berkes and Panizza (2015) argues that despite the negative influence, political stability is not significant in shaping financial development in developed countries.
Considering that SADC countries are all developing countries, with relatively poor institutions, the negative impact of political stability on financial development is upheld in this study. Instability in the political environment and weak democracy in a country impedes FD and are major roadblocks for international organisations such as the World Bank and International Monetary Fund (IMF) that seek to promote financial development in less developed economies (Roe & Siegel 2011). Overall, the generally negative impact of institutions on FD can be explained by the perceived weak and inadequate regulations in the region, which leads to a lack of investor confidence and risks in the financial sector (Biniza 2021). The generally weak and poor institutions in SADC countries are associated with high corruption levels, rent-seeking behaviours and a lack of investor protection, which has largely discouraged investments in the financial sector (Abel et al. 2019; Bekana 2023).
However, findings show that when INSQ is coupled with CI, model 15 reveals that the joint effect on FD becomes positive. An institutional environment that is characterised by a sustained inflow of capital enhances the development of the financial sector. As the SADC weak institutional quality is shown to negatively impact FD, unless interacting with CI, it therefore underscores the need for improving the general institutional environment. This will promote good governance to foster a sustainable financial development that will ultimately lead to economic growth.
The institutional measures that exhibit a positive impact on financial development are VA, as revealed by models 1 and 7 and RQ, in model 4. These findings mean that improvements in democracy and regulatory quality enhances financial sector performance, which confirms a priori expectations. The positive effect of VA and RQ revealed in the model is also echoed by various studies (Ahmadpour 2019; Amir & Gokmenoglu 2020; Asafo & Asmah 2020; Effiong 2016; Gazdar & Cherif 2014; Kombo & Koumou 2021; Marcelin & Mathur 2015).
These results also indicate that the effect of TO from most estimation is negative. This is inconsistent with theory and a priori expectations. This implies that there is generally a high degree of SADC countries interacting with global markets, which has adversely exposed the economies to external economic shocks, particularly fluctuations in commodity prices and exchange rates. This openness to trade has resulted in volatility in capital flows, which disrupts domestic financial markets and subsequently destabilises financial institutions (Agyemang 2022; Kinfack & Bonga-Bonga 2023). The effect of RIR from most estimations is positive. This finding implies that increases in the real interest rate promotes FD in the SADC region. This is inconsistent with classical economists’ view, particularly McKinnon (1973) and Shaw (1973), who argue that RIR is frequently negative in developing countries because of administrative controls on nominal interest rates, coupled with heavy financial market regulation. The INF is proved to have a largely negative influence on FD. This is consistent with Ibrahim (2022) who highlighted that higher inflation rates have a weakening effect on the potency of the financial sector in the quest for efficient resource mobilisation, as it lowers agents’ purchasing power and savings. Furthermore, the regression results reveal that GCF decreases FD in most estimations. This result is contrary to the a priori expectation of a positive influence of GCF on FD. With regard to GDS, the results show a statistically significant positive impact on FD in most estimations. This finding is consistent with the a priori expectation and various empirical studies that revealed a bi-directional causality between domestic savings and financial development (Ang 2011; Bayar 2014; Sahoo & Dash 2013; Tsaurai 2017). It is therefore important for SADC countries to reflect on the economic challenges that need to be addressed to ensure that integrations in global markets, monetary and fiscal policy regimes promote sustainable FD.
Panel Granger causality results
The panel Granger causality test and results are presented in Table 5.
| TABLE 5: Panel Granger causality results. |
Causality testing relates to the null hypothesis that there exists no causal relationship between FD and INSQ, against the alternative hypothesis that there is causality at the panel level (results are presented in Table 5). In terms of causality running from FD to INSQ, the p-value is greater than 5% and therefore, there is failure to reject the null hypothesis. It can be concluded that there is no causality running from FD to INSQ. Conversely, regarding the causality from INSQ to FD, the findings give a p-value of 0.8947, which is also greater than 5%, so there is failure to reject the null. It is concluded that there is no unidirectional causal relationship between the two composite variables.
The Granger causality results indicate that there is no bidirectional and unidirectional relationship between institutional quality and FD in the SADC region for the period under study. However, failing to reject the null does not exclude causality for some individual nations (Lopez & Weber 2017). Hence, country specific causality tests are conducted.
Panel Granger causality tests at country level
Given the variability of countries under consideration, country specific estimations are carried out to better explain causality at country level and results are presented in Table 6.
| TABLE 6: Country specific Granger causality results. |
Table 6 shows that at country level, there is evidence of unidirectional causality from INSQ to FD. This suggests that it is INSQ that determines FD in Angola, Madagascar, Malawi, South Africa and Zambia. This finding is consistent with Ali et al. (2022). On the other hand, unidirectional causality from FD to INSQ is revealed for Seychelles. The result implies that it is the level of FD that determines the quality of institutions in Seychelles. An interesting observation is bidirectional causality between FD and INSQ in Malawi and Angola.
Summary
This study focused on the empirical investigation of the effect of institutions on financial development in the SADC region. The investigation began with data analysis through descriptive statistics and correlation matrix of the variables used in the study. Thereafter, the system GMM estimation results were presented and analysed. The estimation results revealed mixed impacts of the individual institutional variables on financial development. The overall institutional quality index revealed a negative impact on financial development. The nature of political and socio-economic environments in the SADC region, characterised by low growth and constricted infrastructure, is the chief reason attributed to the negative impact of INSQ on FD in the region. However, when interacted with capital inflows, the joint effect on FD became positive. Also, the control variables – TO and GDS – act as pathways to financial development in the presence of good institutions. A monetary policy regime that effectively manages real interest rates and inflation is key to a sustained increase in these factors that impede financial development.
The panel Granger causality could not provide a clear bidirectional or unidirectional relationship between institutions and financial development in the SADC region, which further confirms that all individual institutional variables have different impacts (positive or negative) on financial development in the SADC region. To enhance financial development, it is therefore imperative that the SADC governments implement policies that enhance institutional variables that promote financial development.
As revealed in the study, the financial sector thrives in the presence of better institutional quality. It is therefore imperative for governments of SADC to establish legal frameworks that support the development of capital markets, such as securities exchanges and bond markets. This is necessary to ensure investor protection and market stability. It can also drive economic growth by attracting capital inflows and spurring domestic investment in the financial sector.
Furthermore, authorities should ensure that financial institutions operate in a safe and sound manner and adhere to ethical standards. This also helps to protect consumers from fraud and abuse by financial institutions. Efficient operations of financial institutions are critical in the overall development of the financial sector. In addition, closely monitoring the activities and operations of financial intermediaries can help ensure that these institutions are transparent and accountable to customers and the public. The confidence in the financial sector by various stakeholders also acts as a pull factor for capital inflows to the region. Promotion of competition in the financial sector is crucial for the sustainable development of the sector. For instance, governments can create regulations that promote competition between different types of financial institutions, such as banks and non-bank financial institutions. This can help to ensure that customers have access to a wide range of financial services at competitive prices. Increased competition in the financial sector in the presence of sound institutions is expected to lead to effectiveness and efficiency in the sector, which will consequently pave the way for the growth of SADC economies.
Limitations of the study
Despite the empirical investigation, conclusions and policy recommendations from the study, the research also had some potential limitations. Firstly, there is great deal of heterogeneity among the SADC countries in terms of their economic structures, levels of development and policy environments. Thus, the impact of institutions on financial development may vary across the individual countries; hence, time series analysis for each country can be carried out to cater for the uniqueness of each state. Secondly, the study used the period from 2007 to 2021, because of data availability. However, the period may be limited in capturing long-term trends and structural changes. Thirdly, the findings from this time frame may be different from other time periods; therefore, further research can consider other time periods or extending the time frame.
Conclusion
Future research recommendations
Future research can specifically consider the causality and direction of causality among institutions and financial development in the SADC. The investigations can determine whether institutional quality improves financial development, or FD improves the institutional quality in the SADC region. Moreover, a comparative study can be conducted between SADC and other regional blocs to explore the unique dynamics and outcomes pertaining to institutions, capital flows and financial development. Experiences and policy regimes of the blocs can be compared to explore lessons that the blocs can learn from each other.
Acknowledgements
Competing interests
The author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article.
Author’s contribution
Willard Bhasa is the sole author of this research article. The author confirms that this work is entirely their own, has reviewed the article, approved the final version for submission and publication, and takes full responsibility for the integrity of its findings.
Ethical considerations
An application for full ethical approval was made to the Nelson Mandela University, Faculty Ethics Committee and ethics consent was received on 17 August 2022. The ethics approval number is H22-BES-ECO-089.
Funding information
This research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors.
Data availability
The data that support the findings of this study are available from the corresponding author, Willard Bhasa, upon reasonable request.
Disclaimer
The views and opinions expressed in this article are those of the author and are the product of professional research. The article does not necessarily reflect the official policy or position of any affiliated institution, funder, agency, or that of the publisher. The author is responsible for this article’s results, findings, and content.
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